The Serious Fraud Office has dropped its three-year corruption investigation into the relationship between the embattled Mayfair investment tycoon Robert Tchenguiz and the failed Icelandic bank that had financed him to the tune of £1.7bn.

This was the last remaining element of a disastrous inquiry into the broader activities of Kaupthing, which conducted much of its business out of offices near Tchenguiz's headquarters in Mayfair.

The inquiry had at one stage seen the SFO discuss sending an undercover officer to infiltrate Tchenguiz's favourite Mayfair nightclub, Annabel's, and in March last year led to the most costly series of botched raids ever carried out in Britain.

The agency was forced to admit it had "inadvertently miscast" its search warrant applications in relation to Robert Tchenguiz's brother Vincent – there were, officers later conceded, no grounds at all to suspect wrongdoing. Vincent Tchenguiz has promised to seek more than £100m aggravated and exemplary damages.

The wrongful raids, the agency's then director Richard Alderman admitted, involved "a wholesale challenge to the SFO's competence and the good faith of its staff". A high court judge less than three months ago ordered raids against the both Vincent and Robert Tchenguiz be quashed. Nevertheless the SFO inquiry limped on, with new director, David Green QC, insisting it would continue "with renewed focus and vigour".

The SFO's sprawling inquiry into Kaupthing had been dogged by concerns about complexity and cost since intelligence officers started preliminary work on the case almost five years ago.

It the was the largest, most complex criminal investigation into a financial institution since the SFO examined the 1991 collapse of the Bank of Credit and Commerce International.

However, Alderman took pride in saying he had never asked the attorney general for additional funding to conduct its inquiry, as many of his predecessors had done when faced with large and complex cases.

The investigation was the only UK criminal inquiry into a bank's directors since the credit crunch exposed a series of scandals in the financial sector. The SFO has more recently turned its attention to the Libor interest-rate fixing.

In the eight months before the 2008 collapse of Kaupthing, the bank's UK arm had attracted £2.8bn in deposits from British savers lured by the high-interest online account Kaupthing Edge, which promised depositor protections as good as any from a UK high-street bank. In the end, in the midst of a vicious bank run, the guarantees proved worthless and the then chancellor, Alistair Darling, intervened, using emergency powers to transfer deposits from UK savers to a rival bank, ING.

Meanwhile, tThe SFO's investigation quickly focused on three very different areas: suspected share ramping, allegations of attempted derivatives manipulation and corruptions concerns. But two years ago Alderman decided to slim down the investigation, which he believed was becoming unmanageable and unaffordable.

Senior SFO sources claimed the complex allegations relating to derivatives, for example, were "untriable" before a jury. All lines of inquiry other than corruption allegations – a concept the SFO thought jurors could better grasp – were dropped.

At the heart of corruption allegations was Robert Tchenguiz, the bank's largest customer, to whose business empire the bank had a loan exposure of £1.7bn – substantially tied to his two audacious corporate raid targets: Sainsbury's and the pub group Mitchells & Butlers. According to a subsequent Icelandic parliamentary report into the nation's banking meltdown, lending to Tchenguiz companies was equivalent to more than 40% of the bank's capital base.

The commission concluded it was hard to see how loans to Tchenguiz firms had been advanced "with the bank's best interests in mind".

In March last year some 130 police and fraud investigators conducted dawn raids on the homes and offices of the Robert Tchenguiz and his brother Vincent, as well as a handful of Robert's closest advisers and several UK-based Kaupthing bankers, including former executive chairman Sigurdur "Siggi" Einarsson.

At the same time searches were carried out by Icelandic prosecutors in Reykjavik with whom the SFO had been co-operating closely.

The decision to target Vincent as well as Robert Tchenguiz came as a surprise as the former had not been a longstanding client of Kaupthing.

The brothers, both major Tory party donors, reacted rapidly, recruiting formidable legal teams to pursue a judicial review of the raids' legality. Representing Robert was the former director of public prosecutions Ken MacDonald QC, while going in to bat for Vincent was former attorney general Lord Goldsmith QC.

Extensive details of every element of the allegations being pursued spilled out in open court during the judicial review. Most damaging of all, however, was that the SFO had inexplicably alighted on an allegation that Vincent Tchenguiz had failed to declare to Kaupthing certain pledges he had made to other lenders. This was completely false, as could have been easily discovered by investigators.

Eventually, the court ordered the SFO to return all documents seized in both raids, though the presiding judges did stop short of ruling that there were no grounds for looking afresh at certain of Robert Tchenguiz's activities.

On Monday, however, the SFO's director, David Green, said these avenues had been exhausted. Confining himself yesterday to a short statement, he said the case had been closed "on the grounds that there is insufficient evidence to justify its continuation".

While there was no abject grovelling to Robert Tchenguiz – as there had been to his brother – the termination of inquiries into his relationship with Kaupthing marks the end of the SFO's biggest investigation in a decade.

Tchenguiz responded with an equally short statement through his lawyers saying: "I recognise the SFO have an important role to play in investigations of this nature, and have done my utmost to assist them in any way I can.

"I look forward to closing this chapter and getting on with business."